House Views - September 2020 - The second wave

Macro
As autumn approaches, the coronavirus pandemic continues to spread globally, forcing governments to maintain or reinforce restrictions on activity. After a spurt of rapid growth as economies emerged from months of lockdown, we expect the pace of recovery to slow markedly in coming months, in particular in services as witnessed by the flash Purchasing Manager Index surveys of business confidence for September in the euro zone. However, we do not expect another series of nationwide lockdowns, which should keep economies on a path of gradual recovery. China remains a bright spot with retail sales now rising year-on-year (YoY) while industrial output growth has returned to trend.

Central Banks
Inflationary pressures remain generally in abeyance. Headline consumer price inflation in the euro zone fell -0.4% YoY in August while core prices – i.e., ex food and energy – only inched up +0.2%. This suggests that central banks can continue to focus on supporting growth via asset purchases and targeted support for bank lending. Indeed, the US Federal Reserve (Fed) recently shifted its policy framework in favour of employment and to signal greater tolerance of inflation over time. Moreover, the European Central Bank (ECB) and the Fed stand ready to ease further if activity begins to slide or if financial markets are gripped by turmoil.

Markets
We continue to prefer equities over other asset classes. Government bonds offer little value – given that yields are negative after inflation – with the exception of the additional yield (or “carry”) available on emerging market sovereigns. High quality corporate bonds (Investment Grade or IG) offer only a modest yield premium (or “spread”) over government bonds after registering strong outperformance in recent months. We expect a period of sideways trading in the euro against the dollar after the sharp summer rally. Finally, the recent pullback in gold prices offers an opportunity to add to positions.

Bottom line
We remain Neutral on equity markets in the absence of further easing plans from global central banks. Our preferred region now is emerging Asia where growth should prove resilient this year and valuations look less extended than in the developed world. Given the slowing recovery, we have downgraded euro zone equities back to Neutral. Within fixed income markets, we retain a preference for IG corporate issuers for the carry, even if further spread tightening looks unlikely. Finally, we have taken advantage of a recent bout of weakness to restore gold – our preferred diversification tool – to Overweight in portfolios.

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